The Wages-Fuel-Demand Fallacy

In recent months talking heads, disappointed with the lack of economic recovery,
have turned their attention to wages. If only wages could grow, they say, there
would be more demand for goods and services: without wage growth, economies
will continue to stagnate.

It amounts to a non-specific call to stimulate aggregate demand by continuing
with or even accelerating the expansion of money supply. The thinking is the
same as that behind Bernanke's monetary distribution by helicopter. Unfortunately
for these wishful-thinkers the disciplines of the markets cannot be bypassed.
If you give everyone more money without a balancing increase in the supply
of goods, there is no surer way of stimulating price inflation, collapsing
a currency's purchasing power and losing all control of interest rates.

The underlying error is to fail to understand that economising individuals
make things in order to be able to buy things. That is the order of events,
earn it first and spend it second. No amount of monetary shenanigans can change
this basic fact. Instead, expanding the quantity of money will always end up
devaluing the wealth and earning-power of ordinary people, the same people
that are being encouraged to spend, and destroying genuine economic activity
in the process.

This is the reason monetary stimulation never works, except for a short period
if and when the public are fooled by the process. Businesses - owned and managed
by ordinary people - are not fooled by it any more: they are buying in their
equity instead of investing in new production because they know that investing
in production doesn't earn a return. This is the logical response by businesses
to the destruction of their customers' wealth through currency debasement.

Let me sum up currency debasement with an aphorism:

"You print some money to rob the wealth of ordinary
people
to give to the banks
to lend to business
to make their products
for customers to buy with money devalued by printing."

It is as ridiculous a circular proposition as perpetual motion, yet central
banks never seem to question it. Monetary stimulus fails with every credit
cycle when the destruction of wealth is exposed by rising prices. But in this
credit cycle the deception was so obvious to the general public that it failed
from the outset.

The last five years have seen all beliefs in the manageability of aggregate
demand comprehensively demolished by experience. The unfortunate result of
this failure is that central bankers now see no alternative to maintaining
things as they are, because the financial system has become horribly over-geared
and probably wouldn't survive the rise in interest rates a genuine economic
recovery entails anyway. Price inflation would almost certainly rise well above
the 2% target forcing central banks to raise interest rates, throwing bonds
and stocks into a severe bear market, and imperilling government finances.
The financial system is simply too highly geared to survive a credit-driven
recovery.

Japan, which has accelerated monetary debasement of the yen at an unprecedented
rate, finds itself in this trap. If anything, the pace of its economic deterioration
is increasing. The explanation is simple and confirms the obvious: monetary
debasement impoverishes ordinary people. Far from boosting the economy it is
rapidly driving us into a global slump.

Alasdair Macleod runs FinanceAndEconomics.org,
a website dedicated to sound money and demystifying finance and economics.
Alasdair has a background as a stockbroker, banker and economist. He is a
Senior Fellow at the GoldMoney
Foundation.

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